As the Supreme Court begins its 2014-15 term this month, it will be considering a number of securities cases, including the Omnicare case, which is scheduled for oral argument on November 3rd, and three other cases in which petitions for certiorari are currently pending before the Court. As discussed below, these cases raise significant questions concerning the standards for claims under Section 11 of the Securities Act of 1933, prosecution of insider trading, and the scope of disgorgement penalties in an SEC enforcement action. We also discuss IndyMac, another securities case that had been scheduled to be heard as the first case of the new term on October 6th, but was abruptly dismissed by the Court earlier this week.
Merits Case — Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund. This case, which we have discussed previously, concerns the standard for pleading a claim that a stock registration statement contains an untrue statement under Section 11 of the Securities Act, where the statement involves a matter of opinion. Must plaintiffs allege that the statement was subjectively false – requiring allegations that the speaker’s actual opinion was different from the one expressed – or is it enough to allege that the opinion was objectively wrong? In the proceedings below, the U.S. Court of Appeals for the Sixth Circuit held that it was sufficient for the plaintiffs to plead that a false statement was made; the defendants’ state of mind was irrelevant, the court held, because Section 11 is a strict liability statute.
But other federal courts have taken a different view, holding that “when a plaintiff asserts a claim under section 11 or 12 based upon a belief or opinion alleged to have been communicated by a defendant, liability lies only to the extent that the statement was both objectively false and disbelieved by the defendant at the time it was expressed,” i.e., that it was subjectively false. Fait v. Regions Financial Corp., 655 F.3d 105, 110 (2d Cir. 2011). For example, in Fait the Second Circuit affirmed dismissal of the plaintiffs’ Section 11 and 12 claims based on alleged misstatements concerning goodwill and loan loss reserves in the defendant’s registration statement. The court held that these were matters of opinion based on subjective estimates by the company’s management, and therefore concluded that the claims were properly dismissed because the plaintiffs failed to plausibly allege that the defendants did not believe the challenged statements at the time they were made. See also Rubke v. Capitol Bancorp, Ltd., 551 F.3d 1156, 1162 (9th Cir. 2009) (holding that statements of opinion “can give rise to a claim under section 11 only if the complaint alleges with particularity that the statements were both objectively and subjectively false or misleading”). The choice of standard could have a significant impact on companies’ willingness to express opinions in registration statements for public stock offerings.
In addition to the briefs filed with the Supreme Court by the petitioner Omnicare and the plaintiff shareholder respondents, the case has attracted a dozen “friend of the court” briefs arguing different sides of the issue. (All briefs may be accessed through the American Bar Association here and through SCOTUSblog here.) For example, the U.S. Chamber of Commerce and the Business Roundtable contend that an objective standard, under which issuers could be held liable for genuinely held statements of belief if they are shown to be false, would chill corporate disclosures and deter companies from issuing stock through the U.S. markets. On the other hand, a number of public pension funds argue that requiring plaintiff shareholders to show at the pleading stage that the issuer knew a statement of opinion was false imposes too heavy a burden.
The brief filed by the SEC and the Solicitor General on behalf of the United States takes a middle position. They argue that the Sixth Circuit’s decision should be vacated, but they also contend that stock issuers should be liable under Section 11 not only for statements of opinion that are not genuinely held, but also for statements of opinion that lack a reasonable basis. This may well be where the Court comes out in its decision.
Pending Petitions for Certiorari – Three petitions for certiorari involving securities issues are currently pending before the Supreme Court. Whether the Court considers these cases on the merits will depend on whether the Court decides to grant or deny certiorari.
Moores v. Hildes. The issue raised by the petitioners in this case is whether a plaintiff who acquired stock in a merger pursuant to an allegedly false registration statement may state a claim under Section 11 of the Securities Act, where the plaintiff entered into a “lock-up” agreement committing him to the merger before the registration statement was issued. Can the plaintiff assert a Section 11 claim even though the registration statement played no role in his investment decision? The SEC and the Solicitor General have filed a brief arguing that the Court should grant certiorari to address this question.
Whitman v. United States. This petition for certiorari raises several questions about the standards for prosecution of insider trading in violation of Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. Is the defendant’s knowing possession of inside information sufficient for a criminal conviction for insider trading, even if the information was not a significant factor in the defendant’s decision to buy or sell? Where it is alleged that the defendant violated a fiduciary duty in trading on inside information, should that duty be defined by state law or federal common law? The Solicitor General has opposed the petition for certiorari, arguing that the Second Circuit’s decision affirming the petitioner’s conviction does not implicate any division among the courts of appeal. But the case has drawn significant attention from two law professors. Professor Allan Horwich of the Northwestern University School of Law has filed an amicus brief supporting the petitioner, arguing that only trading driven by the use of tainted inside information should be punished, as opposed to trading where when one merely possesses inside information. And Professor Stephen Bainbridge of the UCLA School of Law, a prolific blogger, has also filed an amicus brief supporting the petitioner’s position that the scope of a corporate insider’s fiduciary duty should be defined by state corporate law.
Teo v. SEC. The question posed by the petitioners in this case is whether a court in an SEC civil enforcement action can order defendants to disgorge profits that were not attributable to their violations of the securities laws but were instead earned as a result of an intervening event unrelated to those violations. As described in their petition for certiorari, they were found liable for violations of Sections 10(b) and 13(d) of the Securities Exchange Act due to their failure to report their increasing stock ownership of a music and home entertainment company. The court then ordered the petitioners to disgorge all of the profits they earned, over $17 million, when the company was acquired as a result of an independent tender offer.
Writ of Certiorari Dismissed – Public Employees’ Retirement System of Mississippi v. IndyMac MBS, Inc. On September 29th, just a week before the scheduled oral argument, the Supreme Court dismissed as “improvidently granted” the writ of certiorari it had previously issued in this case. On September 23rd, the Court directed the parties to file letter briefs addressing the effect of a proposed settlement pending approval in the United States District Court for the Southern District of New York. While the parties argued that the pending settlement proposal would not affect the questions before the Court because the settlement did not include Goldman Sachs, a party to the IndyMac appeal. But apparently the Justices disagreed.
A decision in the IndyMac case would have addressed a split among the federal courts of appeals on whether the filing of a putative class action tolls the three-year statute of repose for claims under the Securities Act of 1933, as established by Section 13, 15 U.S.C. § 77m. In American Pipe and Construction Co. v. Utah, 414 U.S. 538, 551 (1974), the Supreme Court held in an antitrust case that the filing of a putative class-action lawsuit tolled the running of the applicable statute of limitations as to all class members unless and until class certification was denied. In Joseph v. Wiles, 223 F.3d 1155, 1168 (10th Cir. 2000), the Tenth Circuit applied American Pipe in holding that the statute of repose for a claim under Section 11 of the Securities Act was tolled by the pendency of a class action. But in Police & Fire Retirement System of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013), the decision that would have been reviewed by the Supreme Court, the Second Circuit held that while American Pipe tolling applies to the one-year statute of limitations for a Section 11 claim, it does not apply to the three-year statute of repose. The Second Circuit issued a broad holding, which could easily be extended to eliminate tolling of the five-year statute of repose applicable to securities fraud actions under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. For example, in In re Bear Stearns Cos. Securities, Derivative, & ERISA Litigation, 995 F. Supp. 2d 291, 300 (S.D.N.Y. 2014), the court applied this ruling to Section 10(b) claims because “the Second Circuit’s reasoning in IndyMac was based on general principles applicable to all statutes of repose.”
As a result of the Supreme Court’s decision to dismiss the IndyMac appeal, the split between the Tenth and the Second Circuits will remain unresolved. The Second Circuit’s ruling that the statute of repose is not tolled continues to be the law of that Circuit, and in jurisdictions where the issue has not been definitively addressed, potential shareholder plaintiffs will likely act as if the Second Circuit’s ruling applies as a matter of prudence. This holding will potentially prevent institutional investors from waiting to file individual actions until after the class action has progressed through discovery and class certification. It could also encourage early filings by institutional investors and push them to opt-out of class actions earlier than before.